Central Bank Digital Currencies or CBDCs has been on the discussion boards of several countries monetary policies in the last 7 to 8 years as Satoshi Nakamoto’s blockchain innovation which resulted in the creation of Bitcoin (BTC) started to gain grounds in the financial world.
As citizens of the global world, it is a known fact that cryptocurrencies have not been fully embraced by a great part of the population. Statistics show that despite the craze on social media and the enormous returns thus far for several traders, investors and miners, only 1% of the global population use cryptocurrencies.
The remaining 99% of the population have been used to paper money (fiat currency in the form of EUR, GBP, YEN, USD) in the last 100 years and trying to change the trajectory has been difficult. Paper money comes with risks such as the holder being vulnerable to attacks by thieves and thus can be stolen. Despite this risk, people want to see a physical representation of money so that they can take decisions as to when to hoard it and how to spend it coupled with the privacy it affords them in their day to day transactions.
In the last 7 years, numerous central governments from the Americas to Asia have assigned their respective financial regulatory bodies to develop digital currencies to serve as another representation to what citizens are used to as money.
This comes as a result of several citizens losing faith in how central banks regulate money. With an eye on the financial crash of 2008 and 2009 housing market crash, doubts on the part of citizens were heightened when Firefighters and several individuals lost their financial security and homes to sluggish decisions taken by major financial corporations.
After considering central bank digital currency (CBDC) in 2014, People’s Republic of China announced plans of rolling CBDC in 2019 to rival parent crypto Bitcoin (BTC) since it sees cryptocurrencies as a threat to the Chinese Yuan (Renminbi).
China has got a lot to worry about as the year 2021 has seen a boom in crypto investing as Bitcoin has so far led the way and has returned 94.55% Year-To-Date (YTD). The parent cryptocurrency has surpassed several price milestones such as $30,000, $35,000, $40,000, $45,000, $50,000, $55,000 and $60,000.
In the process, it has reached new all-time highs of $61,556.59 in the month of March and trades in the price range of $56.552.22 and $59,713.21, with a 24-hour trade volume of $12.61 billion and market capitalization which has surpassed $1 trillion.
Other altcoins such as Ethereum (ETH), Cardano (ADA), Binance Coin (BNB), Bitcoin Cash (BCH) and tradable tokens (decentralized applications) such as Yearn Finance (YFI), Compound (COMP) and Aave (AAVE) have also brought gains to several investors. In 2021, another section of blockchain called smart contracts has seen great investor interest with Ethereum leading the bulk as the first mover.
To add insult to injury to conventional countries like China and India, states that are NOT sold into the new craze of decentralizing everything and going the opposite direction of traditional finance, there has been the introduction of a new mania called non-fungible token (NFTs).
Started as a test event in 2017, non fungible tokens (NFTs) have so far recorded over $11 billion in market capitalization, with trade volumes of $2 billion in the last 30 days up to the time of writing. In the process, NFTs have increased by 3,347.62%, signaling huge investor interest in another section of decentralized finance (DeFi), blockchain and cryptocurrencies as a whole.
People are selling digital images of their real estates, artistic creations and sports cards for thousands and millions of dollars. So far, an unbelievable $69.3 million was forked out at Christie’s in New York for a GIF (digital image) of Beeple (Mike Winklemann’s) art called “Everydays – The First 5000 Days”.
With such craze, it is extremely understandable that several central banks across various countries are doing everything in their capacity to make citizens of their respective countries believe in their digital tokens.
In the process, creating central bank digital currency will reduce the interest citizens’ show in other digital assets to the barest minimum since interest in cryptocurrencies which promises freedom from intermediaries (traditional banks, clearing houses and insurance companies) cannot be completely eradicated. In the era of supercomputers, people will always find a way to get around authority.
This article conducts an in-depth look into the idea behind the creation of central bank digital currency (CBDC), the pros and cons associated with its creation, countries which look forward to creating CBDCs such as US central bank digital currency, Chinese central bank digital currency, European Central Bank digital currency and the blockchain technologies which are being employed by other countries as well as blockchains which are updating its technologies to meet the needs of creating these digital currencies.
Most importantly, for the average Joe on the street, it would answer the question, what are CBDCs, what are the pros and cons if my country’s central bank decides to issue CBDCs, will money only become potent on a smartphone screen, will CBDCs replace money, what are the potential effects of CBDCs on commercial banks, how do CBDCs differ from cryptocurrencies and can investors make enormous profits from CBDCs like they are currently from cryptocurrencies?
What is Central Bank Digital Currency (CBDC)?
Central Bank Digital Currency (CBDC) does not have a universally-agreed definition. In simple terms, CBDC is a new type of digital currency which governments around the global world are experimenting with, to directly compete with cryptocurrencies and other tradable tokens. CBDCSs have the potential of increasing the efficiency of payments and in the process lower costs since it aims to employ new technology to process payments.
Many CBDCs being considered for creation and adoption are based on blockchain technology and the same principles which gave birth to Bitcoin (BTC) but would be different in its scaling methods.
Since Bitcoin (BTC) provides a great template but has flaws in its ability to scale faster, different algorithms would be explored in order to see central banks meet the growing needs and demands of users if it is fully functional and works side by side with paper money.
There are several proposed features of central bank digital currencies since it is still in the development and testing phase. One of the features which demand the attention of digital currency enthusiasts is Distributed Ledger Technology (DLT).
Globalization has been made possible as a result of the world becoming digitalized and our money has been one of the main constituents of digitalization. Someone in Asia can send money to Africa, another person in America can send money to Europe. Although the current digital money used for our transactions are centralized, technology made it possible for such transactions to be carried out.
Currently, with the introduction of smartphones and mobile phone applications which run on android, iOS and windows, we use financial applications to check our balance and use our credit and debit cards to make payments.
What makes CBDCs unique from other digital assets is that they have a different technological makeup although they are digital. CBDCs would be playing an invaluable role in the re-engineering of money from the ground up borrowing extensively from the underlying technology of Bitcoin (BTC) with distributed ledger technology (DLT).
Instead of a permissionless blockchain such as Bitcoin (BTC) which gives anyone no matter where they are in the world, access to run the software and participate in the sending of money from one destination to the other on the network, CBDCs would be employing a permissioned blockchain.
On a PERMISSIONED BLOCKCHAIN, only a select few can have accessibility to the blockchain. Aside from that, the central entities such as the hierarchy of the country’s financial institution (central bank) controls who is granted permission to the blockchain and the extent of activity they can perform on the technological infrastructure. A great example can be attributed to central banks given permission to party A to read certain details on a blockchain while modification and reading ability is granted to party B.
How Will CBDCs Work As a Permissioned Blockchain?
CBDCs will employ distributed ledger technology (DLT) and this is composed of several copies of the transaction history which is stored and management of those records are held by separate financial entities usually managed in a centralized manner (from a country’s central bank at the top). Sharing of the ledger by these financial entities will be done in a distributed manner instead of having a single central database store the financial records of people.
Pros and Cons of Central Bank Digital Currency
Inasmuch as the possibility of having a central bank digital currency is great news to the ears of several citizens, CBDCs come with some negatives which can bring panic to human society.
On the other hand, many people feel they can rely on this digital asset instead of cryptocurrencies which is entirely decentralized and poses high risk for their hard-earned fiat currencies.
Let us take an in-depth look into the pros and cons of CBDCs as to how it can help us in the future coupled with how it can also destroy an extremely smooth, reliable and trustworthy financial system citizens of the global world have become accustomed to in the last 100 years.
Pros of Central Bank Digital Currency
✅ CBDCs Can Serve As an Interest-Bearing Substitute to Commercial Bank Deposits
Commercial Banks have a primary function of accepting deposits as well as lending funds. Deposits come in the form of time, current or savings. Lending comes in the form of cash credit, overdraft, discounting of bills, advances and loans.
Central Bank Digital Currency can be looked at as a bank deposit when fully accepted. With that, the digital asset would also be subjected to the commitment of banking institutions (such as commercial banks) to honor terms of agreements in a contract whereby it has to make repayments on deposits as interests). Holding physical cash does not yield any interest and bank deposits also come with a risk as some banks can, as others have proven to be during the financial crisis of 2008, abscond with deposits.
There are two types of households which are consistent across geographical areas around the world. They banked and unbanked households. Banked Households are categorized under deposit users while Unbanked Households are categorized under cash users.
With the introduction of CBDCs which pay interest on time and are immune to theft, can go a long way to increasing the welfare of primarily the unbanked household (since dormant fiat currencies do not yield any form of interest). Additionally, the already banked households can make a switch to CBDCs to enjoy relatively higher interest rates which would improve the welfare of their families. CBDCs can be a win-win situation but would provide more benefits to people who do not have much in recorded transactions with financial institutions (unbanked).
✅ CBDC Can Function As an Asset As Well As Transactional Currency
As per studies done by Steve Williamson from the University of Western Ontario titled Central bank digital currency: Welfare and policy implications, CBDC should NOT solely be looked at as an asset which bears interest. It must also be looked at as a means of payment which is a direct alternative to fiat currency (cash) which can be stolen. Together, Central Bank Digital Currency (CBDCs) can be considered as a means of payment which can also pay interest. More importantly, people would not necessarily have to hold an account at a commercial bank to enjoy such rewards.
As per research conducted by David Andolfatto, Senior Vice President of St. Louis Fed in the paper “Assessing the impact of central bank digital currency on private banks”, which contributed to a Literature Review on the digital asset, CBDCs can go a long way to reduce the lending potential of commercial banks through increased trade in a model of decentralized exchange (DEX).
As per the analysis of the money expert, once CBDC is accepted as a digital asset which can function as a medium of exchange and facilitate transactions, several buyers will want to hold more of it just like Ether (ETH), Bitcoin (BTC), Binance Coin (BNB), Tronix (TRX), Litecoin (LTC), Dash (DASH), Bitcoin Cash (BCH) and Dogecoin (DOGE) among others.
This undoubtedly increases the trade between two parties (buyers and sellers) which results in higher quantities exchanged and higher consumption. At the same time, if the portfolio of consumers shows that there is lower deposit balance which results in lower lending by banks (since it doesn’t have enough funds to put out there), there would be reduced investment in commercial banks.
If more people choose to accept CBDC and use them to facilitate transactions (it means there is increased usage and citizens confidence which is larger than investment effect), this means that the welfare of citizens would be increased through CBDC.
Cons of Central Bank Digital Currency
❌ Cashless Society Is a Threat on Your Freedom
Since CBDC helps unbanked households primarily, it also decreases the welfare of the banked (deposit users) since it is bringing direct competition to their centralized yielding instrument. As a result, banked households (deposit users) also have to opt for CBDCs on their portfolios in order to see returns on their hard-earned money. The resultant effect is a MONOPOLY of a CASHLESS SOCIETY which has detrimental effects on the future of fiat currencies (what we know as money).
News of the creation of CBDCs should have been great music to people’s ears. Unfortunately, the gradual transition from fiat currency (which is known as paper money) to an era of digital currencies which was triggered by online payment giant (PayPal) in the early 2000s coupled with the development of mobile payment systems all over the world have raised a few eyebrows from concerned citizens.
The most important question on the minds of almost everyone is how much freedom would ordinary citizens have if central bank digital currency replaces paper money?
On a hunch, Trading Education did an in-depth research across all financial media houses to find out what financial gurus and experts think of the rising situation of the world heading into a cashless future and the results were astounding.
Stefan Ingves (Governor of Sveriges Riksbank, the central bank of Sweden) pointed out in an article published by the International Monetary Fund (IMF) that his country, Sweden, is rapidly moving away from the idea of using cash to facilitate transactions.
Over the last ten (10) years, more than 50 percent of the Swedish population relies on their debit and credit cards or a mobile application on their smartphone to carry out financial transactions.
Seven (7) out of ten (10) citizens say they can manage their day to day expenses without cash and more merchants are expected to stop receiving cash by the year’s end of 2024.
Sweden was prioritized because it has the oldest central bank in the world. The country’s lead in shifting toward digital money is of great concern for the rest of the world since globalization has created a system of following change in order to keep up with the modern way of going about business activities.
As per data retrieved from Statista (an online statistical portal which reports consumer data and market trends) published by Raynor de Best on 12th November 2020, reported that in 2018, the most common method of payment in the United States was credit card which was closely followed by debit cards (2nd) and then cash (3rd).
In 2019, more than 70 percent of Americans reportedly found using their smartphones to make payments extremely appealing. The primary usage was centered on checking account balance and purchasing products online.
Several people trust PayPal, ApplePay and Google Wallet as the online payment methods for their transactions. In 2020, there was a $170 billion worth of non-cash transactions in North America with $98.88 billion as proximity mobile payment transaction value in the United States.
Not too surprising, in the same report, it was revealed that using mobile phones for transactions posed many security concerns regarding the safety of the details of the transactions.
In several videos trending online about the future of money with an eye towards the billions of dollars transacted digitally, a group of analysts have weighed in. Their main concern is that digital products came in to complement physical products, it should not replace it.
The analysts on YouTube’s financial commentary channels pointed out that, “Digital products provide an added layer of security, since a loss of a physical copy can be reproduced to make up for any loss incurred. Two is better than one, so why the rush to move every activity including the coal which powers the world’s industry (money) to only the digital world”.
The analysts further opined that as soon as central bank digital currencies are released, the real freedom of people would be tested to the very core. This is because money will become numbers on a screen and your credit could be wiped off through technical faults which may take days or months to resolve.
What if you are completing a transaction which does not have any illegal theme to it but must be conducted in a private manner?
What if you are late on tax and have decided to settle Uncle Sam the next month, only to receive a notification of a deduction of taxes from all your accounts which renders you broke and penniless?
Since most ledgers are not built for payments and as such cannot handle a high volume of transactions, what if you want to buy something at a store which is urgent for your survival and there are network problems? Especially for emerging economies which are warming up to the idea of decentralized finance and the possibilities associated with it.
CBDCs are great but need to be thoroughly assessed and adopted in addition to fiat currency to give citizens several options of payments. If authorities do not include it as such and CBDC becomes the only medium of exchange which can facilitate transactions, high congestion which may bring up technical problems will make the world a living hell.
What Blockchain Technologies Lead The Way For The Creation Of CBDCs?
More than 80% of the central banks in the world are exploring ways to create some form of digital currency. Although it would create new opportunities for citizens, blockchain technology is known to have one particular problem which is called SCALABILITY.
As a result, which blockchain technologies are being considered by major central banks of the world and what blockchain technologies are updating their technologies to claim the larger share of the CBDC market?
On Monday, 4th January, 2021, it was announced by the Ministry of Digital Transformation of Ukraine that it is in a partnership with the Stellar Development Foundation (SDF) which will see the cryptocurrency company use its unique technological solution to help Ukraine build a national digital currency. In the process, a memorandum of understanding (MOU) was signed to formalize the whole process.
Chief Executive Officer of Stellar Development Foundation, Denelle Dixon said of the partnership, “We’ve been in conversations with governments and institutions all over the world about the key considerations for issuing central bank digital currency (CBDC). It’s important to remember many, if not all, of these organizations weren’t designed to be technology companies and that they have many audiences that they are supporting. That makes a public-private partnership so essential to getting this right.”
In a statement, Digital Transformation and Information Technology Deputy Minister, Olesksandr Bornyakov responded that, “The Ministry of Digital Transformation is working on creating the legal environment for the development of virtual assets in Ukraine. We believe our cooperation with the Stellar Development Foundation will contribute to the development of a virtual asset industry and its integration into the global financial ecosystem”.
What won this partnership for Stellar was its unique feature algorithm which is called Stellar Consensus Protocol (SCP) which processes 1,000 up to 5,000 transactions per second (TPS). This means that Stellar’s Network is 100 to 500 times faster than Bitcoin (BTC), the pioneer of blockchains and 50 to 250 times faster than Ethereum (the first mover of smart contracts leading the way in decentralized finance and non fungible tokens).
As per the words of the Chief Operations Officer (COO) of Stellar, Jason Chlipala, Stellar Consensus Protocol (SCP) provides unique certainties to issuers they would not find in other blockchains.
In the first week of March, 2021, Ripple (XRP) launched a new project which will see the cryptocurrency company which is well-vexed in cross-border payments, pilot private ledgers for central banks which aim to launch central bank digital currencies in the near future.
This will provide central banks with “A more secure, flexible and controlled solution for the issuance and management of digital currencies”.
Ripple understands that most blockchains are built as public ledgers which can be accessed by all manner of persons no matter where they find themselves in the world so long as they have internet connection. Additionally, public ledger blockchains use a broad network of validators. Central Banks on the other hand, would like to take a centralized approach where privacy and control over how a ledger is maintained will be prioritized.
Ripple also aims to enable the feature of interoperability to help with the distribution of data among institutions which have access to the ledger such as central banks at the top, commercial banks and other financial entities.
According to a representative of Ripple, private ledger would have the same features of the current technology powering the XRP ledger which means CBDC Private Ledger would be purposely built for payments. CBDC Private Ledger will fasten the movement of money, is reliable and cost-effective.
Evidently, Ripple’s technology is not based on the proof-of-work (POS) algorithm used by Bitcoin (BTC) and Ethereum (ETH) 1.O but by a CONSENSUS PROTOCOL. Ripple (XRP) can handle 1,500 transactions per second (TPS) minimum which has been currently updated to a maximum of 50,000 transactions per second (TPS), the same scaling numbers of VISA. Such numbers are essential as it would meet the volume required by central banks.
The core technology behind the Private Ledger has been running for a little over eight (8) years without any incidents and as a result provides high security standards since every CBDC will have its own unique privacy standards and policy requirements.
How Will CBDC Impact Commercial Banks?
If Central Banks are able to carry out their plans of releasing CBDCs into the financial system, it is going to bring strong competition to the commercial side of the banking sector. This is because commercial banks primarily have two functions which are to receive deposits and usher out loans to customers.
If central bank digital currencies (CBDC) are able to offer interest-bearing assets, it would directly compete with bank deposits of commercial banks. Once this happens, it is imperative on the part of the executives and regulators of commercial banks to act and change the deposit rates offered to savers. This will impact the funding cost of banks as they have to change the terms of agreement and give customers great returns on their investments (deposits).
Because of the introduction of CBDCs which may offer great interests, the number of bank deposits which would be supplied to the market would be relatively lesser. Once this happens, the volume of lending backed by INTERMEDIARIES (primarily traditional banking institutions) may change over the course of time.
As a result, CBDCs may serve as a replacement of the main source of funding for the commercial side of banking which are direct deposits and cause commercial banks to cease since they are not needed as intermediaries that would have to oversee transactions. Additionally, commercial banks monopoly of given out loans (lending) would also be limited (decreased).
Commercial Banks May Offer a Different Response
Since many people would opt for CBDCs because they want to free themselves from low interest rates, there would be an increment in the demand of deposits for CBDCs. This would come through an intensive margin (when existing depositors are encouraged to save more) and extensive margin (when several people who are or unbanked are encouraged to use CBDCs since the banking system has failed them with their low interest and monopoly of people’s financial lives).
COMMERCIAL BANKS can therefore respond to the release of CBDCs by raising the equilibrium deposit rate (profit) so that it would become equal to the interest rate offered by CBDCs. When this happens, there would be no change in interest rates, investment opportunities or a need for people to opt for CBDCs instead of deposits. With this, commercial banks could avoid DISINTERMEDIATION and continue to stay in operation.
What Countries Are Considering Creating Central Bank Digital Currency (CBDC)?
According to a report by the Bank for International Settlements (BIS) which asked 66 central banks (most of them were from developed economies with high human development index and others came from emerging economies), if they have plans on creating CBDCs in the near future.
The report was released on Thursday, 23rd January, 2020 and details of the report pointed out that 80% of the 66 banks (52.8) were involved in CBDC work, 26.4 (40%) confirmed they have accomplished the experiment milestone and were now focused on the development of proofs of concept.
Overall, there has been a 10% increment in the number of central banks which are working on creating central bank digital currencies for their countries since a similar survey was last carried out in 2018.
CHINA announced plans of creating a digital currency for its citizens as far back as 2019 to rival cryptocurrencies, particularly parent crypto Bitcoin (BTC). The country’s primary objective is to decrease their citizens' interest in investing or using cryptocurrencies to pay for goods and services in their day to day lives.
The Chinese government through its representatives has opined that cryptocurrencies are disrupting a very great financial system. CBDCs could control the flow of money and keep track of all transactions to be able to prevent fraud, money laundering or finance of evil (terrorism) acts.
As of November 2020, the Digital Yuan Initiative is in the testing phase as China aims to become the first country in the world to have a fully functioning digital currency system to complement the Chinese Yuan.
The European Central Bank (ECB) looks forward to issuing a European Central Bank Digital Currency (ECBDC) together with five (5) other central banks (Switzerland, Japan, United Kingdom, Sweden and Canada).
These countries would be sharing findings from their individual projects which would go a long way to help them improve the quality and adoption of the digital currencies by their citizens. It was reported that the members assigned to this project would be working closely with the Committee on Payments and Market Infrastructures (CPMI) and the Financial Stability Board.
In the United States, researchers at the Federal Reserve Bank of Boston and the Massachusetts Institute of Technology (MIT) have made plans to launch a prototype of central bank digital currency systems as early as the Summer of 2021 (July or August) as per Bloomberg Report.
The leader of the James Cunha said of this project that “The team will unveil at least two (2) platforms capable of moving, storing, and settling digital dollar transactions”. It has earlier on been reported on major financial news outlets that the government of the United States through its Federal Reserve seems more eager to preserve the privacy of its citizens in case there is an adoption of CBDC along the line.
Will CBDCs Replace Paper Money?
As per the research done by Trading Education, most of the countries experimenting with the creation of a digital currency consider it as a SUPPLEMENTARY CURRENCY to deal with the emergency of cryptocurrencies which keeps soaring in price and adoption as a transactional currency.
If we are to go by the top two countries by gross domestic product (GDP), United States of America (USA) and China, then CBDC would not be replacing paper money in the future. The government of the United States is prioritizing the privacy of its citizens and what this means is that in case of a release of CBDCs, the digital asset is not going to be entirely decentralized like BTC, ETH or DASH. It would be regulated in the same way as USD.
People’s Bank of China Deputy Director, Mu Changchun stated in 2019 when China assured the rest of the world its creating a CBDC that “By issuing a digital currency, it expects to reduce the demand of cryptocurrencies and hope the digital asset will enable the consolidation of the national currency’s sovereignty”.
Overall, the deputy director believes CBDC will help control anonymity and prevent money laundering, fraud or financing of terrorism acts.
CBDCs in Comparison with Cryptocurrencies
CBDCs and Cryptocurrencies have something in common but they have lots of differences. Cryptocurrencies and CBDCs are assets which can only exist digitally. There would not be any forms of the coins or tokens physically which would be used to conduct transactions. They are online assets which can be used over the internet.
Unfortunately, their relationship in terms of where they are going or are operating differs. Central Bank Digital Currencies will run on permissioned blockchains while Cryptocurrencies run on permissionless blockchains.
Permissioned Blockchains (CBDCs) are technological solutions which run online but cannot be accessed by everyone. A great example can be attributed to sharing a Google Document with a friend. You always have the option of allowing everyone with the link to see it or “a select few” to view contents of the document. If you allow a select few to see it, you have to grant them permission to access the documents. This is how permissioned blockchains operate (not entirely accessible to just anyone).
Permissionless Blockchains are what decentralized applications and cryptocurrencies run on. Anyone on the face of the internet with an internet connection is granted an automatic access to the contents of the technology. This can be explained better with the same Google Documents example. Once you set the command of viewing to “anyone on the internet with the link”, everyone has permissionless access to the documents and can see contents of the material at any time.
For CBDCs, there is a central entity (government’s central bank) that has authority over the proceedings of the digital currency. On the other hand, with cryptocurrencies, anyone can run the software and go about their transactions (buy, sell, hold) without any authority from any single individual or organization.
CBDCs may be a great response and rival to cryptocurrency. There are several instances where numerous people have lost some or their entire investment in a cryptocurrency operation which has brought questions about its legitimacy.
If CBDCs can find a balance between centralization and decentralization, it would be able to expand the set of payments and savings options available to households particularly, the unbanked.
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